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Wednesday, 10 March 2021

What do rising US treasury yields mean for bonds, stocks, and the EGP?

How will rising US treasury yields affect Egypt? The country’s all-important carry trade could come under pressure as emerging-market bonds, equities and currencies have been losing out on relative appeal as US treasury yields have surged in recent weeks from their covid-19 lows. Analysts we spoke to say FX buffers and a stable EGP, plus a high real rate offered by EGP debt, make us comparatively safe in the medium term.

But this is just relative to other EMs and a long-term increase in US treasury yields and the return of inflation globally (as the world recovers from the pandemic) could create issues for foreign portfolio investment down the road, leading to pressure on the EGP and lower foreign investor appetite for the EGX.

IN THE HOT SEAT TODAY- Pharos’ head of research Radwa El Swaify, EFG Hermes head of macro research Mohamed Abou Basha, and HC Securities chief economist Monette Doss help us digest the wider implications.

How far have US yields increased? 10-year treasuries broke above 1.6% in late February, after having closed 2020 well below 1%. It eased at the start of March, but the passage of President Joe Biden's USD 1.9 tn covid relief plan on Saturday took it back to the one-year high, and it has been fluctuating within the 1.5-1.6% range since then.

In short: treasuries now offer investors 1.5x better returns than they did earlier in the pandemic. The surge in yields guided the MSCI gauge of emerging-market stocks to a two-month low at the start of the second week of March — bringing back memories of the so-called “Taper Tantrum,” when the Fed began in 2013 to roll back its large bond-buying program, making US bonds cheaper and triggering an exodus of capital from emerging markets.

Anxiety remains particularly high that we’re about to see another wave of outflows, especially after a statement from Fed Chairman Jerome Powell last week failed to signal the Fed will act to stop surging treasury yields.

But in the medium-term, Egypt is on the safer end. “We’re relatively immune” to higher treasury yields as EGP-denominated treasuries offer high returns at lower risk compared to other EMs, Pharos’ Radwa El Swaify told us. Real rates on EGP bonds — or the yield adjusted for inflation — remain among the highest in the world. We also stayed open and were among only a handful of economies to grow despite covid, El Swaify added.

Foreign holdings of Egyptian debt recovered to exceed their pre-covid level, rising to USD 29 bn at the end of last month. This came after a pandemic-induced EMs-wide sell-off between March and May, when investors dumped 60% of their holdings. Any potential reversal to inflows should US treasury yields continue to increase is likely to weigh on this recovery.

We were recently left out of HSBC’s list of emerging markets most vulnerable to a possible tantrum. The country doesn’t fit the vulnerability profile as much as Brazil, Indonesia, Mexico and South Africa — who have a history of running current account deficits or have large debt piles, plus a debt mostly held by foreigners. In Mexico, foreigners hold 46% of the government’s local-currency debt, while in Egypt this number was closer to 12% at the end of FY 2019-2020, figures from the CBE (pdf) show. Though we remain relatively less vulnerable, a high-debt-to-GDP, which currently stands at 87%, as well as structural issues, could affect our ability to handle long-term shocks.

Strong FX reserves have kept the EGP more stable: The central bank and the banking system have been building a healthy stock of FX reserves and net foreign assets, El Swaify emphasized. This has been allowing the EGP to USD exchange rate to remain stable and eliminates the risk investors would face from a sudden depreciation, she said. The stock of reserves helped the EGP remain intact even when the covid-inspired sell-off that swept EMs earlier in 2020 wiped off nearly USD 10 bn from EGP bond portfolios, she pointed out. The CBE’s stock of foreign reserves inched up to USD 40.2 bn in February, up USD 100 mn from January, but still below its pre-covid peak of USD 45.5 in February 2020.

Analysts don’t see the EGP sliding (much) against the greenback this year: The currency could depreciate by 3% vis-a-vis the USD by the end of the year as low domestic inflation inches up later in 2021 because of higher prices in the US and Europe, key trading partners for Egypt, HC’s Monette Doss told us. This would bring the EGP to USD to a little over EGP 16 per one USD, up from its current average of EGP 15.66 to the greenback. Pharos also made a close forecast late last year, seeing a nominal rate of EGP 16.00 to the USD by the end of FY2020-2021 and expecting the same annual average for three years.

But we could face more volatility this time around: While comparably less vulnerable, Egypt is more so than it was before the pandemic hit, EFG Hermes’ Mohamed Abou Basha said. Foreign reserves are still short of their February 2020 peak. This means the central bank now has “relatively” less room to counteract sharp portfolio outflows or a loss of a key source of foreign currency, especially with covid still weighing on tourism receipts, Abu Basha tells us.

And we might already be witnessing slower inflows: Foreigners have been increasing their holdings by a monthly average of USD 1.25 bn so far this year, down from an average of USD 2.2 bn when the recovery from the covid slump was underway in 2H2020, Doss told us, citing her firm’s calculations. “Egyptian treasuries are currently facing higher competition due to rising yields in the USA and Turkey … [and] this is clearly reflected … with yields on 12M T-bills increasing by 30bps since the beginning of 2021.” Global inflation is also on the rise, increasing the risk of monetary tightening and higher interest rates.

Another risk of monetary tightening looms: Abou Basha doesn’t expect the low interest rate environment globally to change soon, but points out that when world central banks start to gradually tighten policy, we might see pressure on the CBE to follow suit to protect foreign inflows. This would be a reversal of the CBE’s easing cycle — and remember, lower rates are key to prompt corporates to start taking on debt to support capital expenditures.

What about the impact of rising US yields on the EGX? Foreigners are smaller players, and US yields aren't as strong a factor in attracting more of them, El Swaify told us. The primary issue for the EGX is the lack of new paper. The only time foreigners returned to the EGX “with momentum” was when Fawry went public in 2019, she added. Investors want “high growth stories,” and fintech and banking are major themes that interest foreigners as this market is highly underpenetrated.

The EGX has been suffering from a dearth of new listings in recent years: Early 2020 brought only a single new name: mid-cap real estate player Emerald (and that was even before the pandemic hit in March). There are a number of planned listings in 2021 that raise hopes the IPO pipeline will flow again, including an upcoming of 49% of CI Capital portfolio company Taaleem Management Services, a 2H2021 planned listing by non-banking financial services provider Ebtikar, and a potential dual listing by LSE-traded diagnostics powerhouse IDH.

The EGX30 fell 0.9% at today’s close on turnover of EGP 1.5 bn (1.6% above the 90-day average), the second day in a row it has closed in the red. Foreign investors were net sellers. The index is up 3.6% YTD.

In the green: Orascom Investment (+4.9%), CI Capital (+1.3%) and Sidi Kerir (+1.3%).

In the red: Ezz Steel (-2.5%), Fawry (-2.5%) and Heliopolis Housing (-2.1%).

CATCH UP QUICK on a handful of other stories that should probably be on your radar this afternoon:

  • Syria’s Antaradous will pay almost USD 40 mn (plus interest) in compensation to Amer Group and Porto Group after a Cairo Appeals Court decided on 22 February to uphold a 2019 arbitration ruling in Amer and Porto Group’s favor, Porto said in a statement (pdf) yesterday. The dispute centers on a failed partnership ona project in Tartous. The case has gone through several rulings since 2019, when the Cairo Regional Center for International Commercial Arbitration first ruled in favor of Amer and Porto Group in 2019, ordering Antaradous to pay USD 39 mn in compensation.

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